Putting Brakes On High Frequency Traders

Trading speed does not constitute the root of contemporary market-structure problems. Problems abound, and many stem from the move to decimalization in the Clinton years, but the 'race to speed' isn't really central to that picture.

That is a quick summary of the conclusions of one careful observer of the field, James Angel, a consultant with broker-dealers and law firms on market structure issues.

At a meeting of the the European Parliament’s Economic and Monetary Affairs Committee in February, an MP from Bavaria, Markus Ferber, proposed a minimum resting time, a period of 500 milliseconds (half a second) between the posting of an order and the earliest possible cancellation thereof.

The UK’s Foresight Project responded with a white paper, timed to meet Europe's legislators and bureaucrats as they return from their summer lull and get back to work on such matters, which cautions that the “Ferber amendments” could have unwanted consequences, such as the impairment of valuable hedging strategies.

Angel's view on the Ferber proposal

I asked Angel whether a minimum resting time seemed an appropriate response to the concerns HFT has raised on both sides of the Atlantic. He wasn’t very impressed. First, he said, “there has always been a race for speed, and it doesn’t matter in principle whether you are too late by a minute, a second, or a millisecond. You are too late in either case.” The speed-quest as an element in financial history has even given rise to legends, like that of Baron Rothschild and the carrier pigeons that are said to have brought him early news of the outcome of the Battle of Waterloo.

This venerable race for speed isn’t going to come to an end by virtue of the half-second rule Ferber has in mind, said Angel. “Though there is a ‘quote pollution’ problem, certainly, many cancellations are from legitimate market makers updating their quotes. This rule would be catnip for the HFT traders who are taking liquidity. It would benefit sharpshooters, like the SOES bandits of old who will see the market makers, stuck in a position for a half second, as plump targets to be picked off when the markets move.”

[As reminder: in the late 1980s a group of traders associated with Datek Securities learned to exploit a weakness in Nasdaq market’s Small Order Execution System (SOES), through a trade-scalping program called Watcher.]

Angel added that he would be happy to see Europe attempt to institute a Ferber rule, “because it would be an experiment that might well provide valuable data. But on its face it looks like a well-intentioned idea destined to go wrong.”